What Are the Origins of Freddie Mac and Fannie Mae?

by Rob Alford

Mr. Alford is a student at the University of Washington and an HNN intern.

Editor's Note: This article was published in 2003.

In recent months, the nation's two largest mortgage finance lenders have come under increasing scrutiny at the hands of Congress, the Justice Department and the Securities and Exchange Commission (SEC). The Federal National Mortgage Association, nicknamed Fannie Mae, and the Federal Home Mortgage Corporation, nicknamed Freddie Mac, have operated since 1968 as government sponsored enterprises (GSEs). This means that, although the two companies are privately owned and operated by shareholders, they are protected financially by the support of the Federal Government. These government protections include access to a line of credit through the U.S. Treasury, exemption from state and local income taxes and exemption from SEC oversight. A recent accounting scandal at Freddie Mac that resulted in the replacement of three of the company's top executives has led to mounting concerns over the privileged status these GSEs enjoy in the marketplace.

Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt's New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.

Initially, Fannie Mae operated like a national savings and loan, allowing local banks to charge low interest rates on mortgages for the benefit of the home buyer. This lead to the development of what is now known as the secondary mortgage market. Within the secondary mortgage market, companies such as Fannie Mae are able to borrow money from foreign investors at low interest rates because of the financial support that they receive from the U.S. Government. It is this ability to borrow at low rates that allows Fannie Mae to provide fixed interest rate mortgages with low down payments to home buyers. Fannie Mae makes a profit from the difference between the interest rates homeowners pay and foreign lenders charge.

For the first thirty years following its inception, Fannie Mae held a veritable monopoly over the secondary mortgage market. In 1968, due to fiscal pressures created by the Vietnam War, Lyndon B. Johnson privatized Fannie Mae in order to remove it from the national budget. At this point, Fannie Mae began operating as a GSE, generating profits for stock holders while enjoying the benefits of exemption from taxation and oversight as well as implied government backing. In order to prevent any further monopolization of the market, a second GSE known as Freddie Mac was created in 1970. Currently, Fannie Mae and Freddie Mac control about 90 percent of the nation's secondary mortgage market.

GSEs such as Fannie Mae and Freddie Mae, with their combination of private enterprise and public backing have experienced a period of unprecedented financial growth over the past few decades. The current assets of these two companies combine for a total that is 45 percent greater than that of the nation's largest bank.

On the other hand, their combined debt is equal to 46 percent of the current national debt. It is this combination of rapid growth and over leveraging that has lead to the current concerns of Congress, the Justice Department and the SEC with regards to the financial practices of these GSEs.

Fannie Mae and Freddie Mac are the only two Fortune 500 companies that are not required to inform the public about any financial difficulties that they may be having. In the event that there was some sort of financial collapse within either of these companies, U.S. taxpayers could be held responsible for hundreds of billions of dollars in outstanding debts. A recent investigation by the Justice Department and the SEC into the accounting practices at Freddie Mac revealed accounting errors in the amount of 4.5 to 4.7 billion dollars and resulted in the termination of three of the company's top executives. Ongoing investigations by Congress, particular the House Finance Services subcommittee that oversees the activity of GSEs, will determine the future role of Fannie Mae and Freddie Mac and the secondary mortgage market that they dominate.

More Comments:

Robert Erwin Taylor -
1/24/2010

FNMA and FDMC are both examples of what Ayn Rand termed the "mixed economy". Currently our economy is a mixture of capitalism, socialism and fascism. If you know the definition of each I need not explain...it's apparent. What is needed is a thorough separation of business and state similiar to the separation of church and state, i.e. no more subsidies, grants, bailouts, ACORNS, etc. Lobbies would be non-existent because there would be no special favors such as Senator Dodd's kickback with Countrywide Mortgage. Combine this separation with the elimination of the IRS replaced with a federal sales tax and the American economy would explode. Winners: large and small businesses and the consumer. Losers: Either go bankrupt(voluntary or involuntary) or sell to more efficient companies and/or investors.

stan miers -
1/12/2010

somehow ordinary americans will look at both freddie mac and fannie mae with mixed feelings. both played crucial parts in america's homeownership. sadly, some of the policies of both entities contributed to the problems being faced by consumers today as evidenced in various research paper and term paper.

Greg Pennington -
10/14/2008

The pass through was never implicitly guaranteed by Fannie or Freddie, only on Ginnie Mae pools. Without this bailout, the pass through may never have happened. If it were not for the fact that the majority of these securities were held by foreign governments, the dividends that were guaranteed by H.R. 3221, nor that portion of the bailout that allows it to continue, would never have been allowed.

ACORN's involvement did not force institutions to create subprime product. Nor did it lead to the creation of tranches. ACORN's involvement came because of bank and thrift institutions inability to lend in poorer areas even when some of the people qualified.

You will note that subprime product was used on a great many people who qualified for A paper product, which was the next big headline before the meltdown.

Why did you need more regulation when all of the laws necessary to govern this product lay with the securities agencies whose job it was to rate the product? You could add all of the regulation in the world, but if people do not do their job, nothing will get accomplished.

ACORN is not filled with angels or saints, but blaming this event on a non-profit whose total contribution to loans as a whole are less than a percent, will allow this kind of debacle to take place again.

You can find blame with democrats and republicans, but legislation that was not passed, and non-profits suing banks are not what caused the current issues.

Greg Pennington -
10/14/2008

Look at the PAC column under Obama and Clinton. The donations come primarily from individuals at the organization not lobbying sponsorship as a whole.

You can speculate on what side of the political fence someone lands on, but nobody is clean here, and there are no easy answers. If you own a home and got a decent rate anytime since 1985, it was due to securitization. The pressure to purchase, not originate sub-prime product was what brought the demise. As well as lack of oversight on the division of subprime product into tranches included into "good loan product". If the oversight would have been done properly, we would never be in this mess at the real estate mortgage level.

Watch it continue as the same process was allowed on commercial product as well.

Robert Lee Gaston -
10/13/2008

You left out one. How about the Central Banks all over the world who bought this stuff? I wonder if they had any idea the U.S. debt they were holding was essentially bad paper. And they wonder why the dollar is weak.

Robert Lee Gaston -
10/13/2008

Who would pay off Rep Frank and Sen Dodd? Think man, think.

Hugh Conrad Young -
10/4/2008

Why don't we hear about how sub prime mortgages that were forced on the local bankers by groups created to get greater political power? How Fannie and Freddie converting them into derivatives or grab bags paying 13% return guaranteed by the Federal Gov’t thru Freddie and Fannie. Sub-Prime mortgages bundled with good mortgages turned into a derivative security sold to Wall Street backed by the federal gov’t.
What about the graft and corruption in Freddie and Fannie? What about all of the Reforms that the Democrat’s blocked.
Obama was a Community Organizer and Lawyer and group organizer for Acorn, the group that used Gestapo tactics to force Banks and mortgage lenders to buckle under and give mortgages to groups that could not afford them. Let’s follow the trail from sub-prime to Fannie and Freddie to Congress to Wall Street thru gov’t guaranteed derivatives.
The gov’t caused the problem starting with Jimmy Carter and the Democrats creating a scheme to buy votes with Home loans in the sub-prime market. The gov’t caused this problem. The gov’t has to clean up this mess.

Dale McClain -
9/26/2008

Judging from the tone of the articles, it's clear what side of the political fence you sit on. A few indisputable facts:

1. Quote from Barney Frank (D) during hearing on GSE regulation in September 2003:

"I want to begin by saying that I am glad to consider the legislation, but I do not think we are facing any kind of a crisis. That is, in my view, the two government sponsored enterprises we are talking about here, Fannie Mae and Freddie Mac, are not in a crisis."

Through his influence as chairman of the financial services committee, GSE regulation was not enacted.

2. Skip ahead to 2005. Alan Greenspan testified before the Senate Banking committee and said the following:

"We at the Federal Reserve remain concerned about the growth and magnitude of the mortgage portfolios of the government-sponsored enterprises, which concentrate interest rate risk and prepayment risk at these two institutions and makes our financial system dependent on their ability to manage these risks," Mr. Greenspan said. "To fend off possible future systemic difficulties, which we assess as likely if G.S.E. expansion continues unabated, preventive actions are required sooner rather than later."

Charles Schumer's (D) response was the following:

In several pointed lines of questioning, Senator Charles E. Schumer, Democrat of New York, criticized Mr. Greenspan's recommendation and called it both inconsistent with his other views on regulation and potentially damaging to the housing markets. Without identifying anyone in particular, he also suggested that some people who have advanced tougher regulation of the two housing finance companies are really pushing a broader agenda to eliminate the companies and their mission of providing affordable housing.

"I see an analogy to Social Security," Mr. Schumer said. "Social Security has a problem and there are ideologues who want to undo it. Fannie and Freddie have problems and there are ideologues who want to undo them. But there are ways to fix the problems short of what's been proposed. When the sink is broken, you don't want to tear down the house."

In 2006, John McCain said the following in favor of GSE regulation:

"For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac-known as Government-sponsored entities or GSEs-and the sheer magnitude of these companies and the role they play in the housing market. OFHEO's report this week does nothing to ease these concerns. In fact, the report does quite the contrary. OFHEO's report solidifies my view that the GSEs need to be reformed without delay.

I join as a cosponsor of the Federal Housing Enterprise Regulatory Reform Act of 2005, S. 190, to underscore my support for quick passage of GSE regulatory reform legislation. If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.

I urge my colleagues to support swift action on this GSE reform legislation."

It might also interest you as to who received lobbying money from Fannie Mae and Freddie Mac. Barack Obama is number 2 on the list.

Turns out putting people in homes they can't afford is a bad idea. Now we are all faced with paying the bill.

irene Willett -
9/26/2008

I stumbled upon this article which speculates that if there was ever a collapse of any of these corporations, the US taxpayers may be responsible for billions of dollars. Well, isn't that interesting? It took 5 years before anyone sat up and took notice. The subcommitte developed to "investigate" the problems with fiscal practices at fannie mae and freddie mac apparently didn't catch on what was happening until now. Scary.

Sean Yard -
9/10/2008

Well said. But you want accountability. In Washington? rofl.

Sean Yard -
9/10/2008

"Fannie Mae held a veritable monopoly over the secondary mortgage market. In 1968...In order to prevent any further monopolization of the market, a second GSE known as Freddie Mac was created in 1970. Currently, Fannie Mae and Freddie Mac control about 90 percent of the nation's secondary mortgage market. "

So the government decides in order to prevent a monopoly, it must create a second beast to compete with the first one they created that is now monopolizing the market???

That makes no sense to me, maybe I am just crazy? Stupid?
And a good number of Americans want the government to be in charge of our health care, can't wait to see how that turns out.

Robert A Zuluaga -
9/9/2008

My gut tells me this bailout is putting a band aid a a much deeper problem.

Has anyone had the courage to ask the unasked question - What would happen if we held these long established GSE's accountable for their actions?

What if we took the time to trace the chain of command through the government and corporate web and get to the bottom of the funny money and mortgage magic?

Why not prosecute and remove these board members and government cohorts and let the free market economy find it's bottom and birth fresh and improved guidelines that let the GSE's and their directors pick up their own tab including appropriate prison time?

Is that too devastating a thought to think? How can something good come from a practise so flawed? Are we just putting off the inevitable and expecting the taxpayers (and our children and grandchildren) to pick up the tab?

I feel angered and frustrated that many of my fellow Americans think and really believe that the government will come to our rescue. It is time to shake this tree of collusion of government and powerful monied interests. Obama change? McCain change? I like the idea of naming the congressmen and senators behind the pork. That could be a start. Ah - but the federal reserve and Fannie and her brother Freddie. That will take courage and our support.

Maybe the government could put a cow in every home and a box of garden vegetable seeds for every neighborhood as we weather the storm.

J. D. MacDonald -
9/7/2008

In quest of proper English, (From a University Publication(?).) : "...with regards to the financial practices of these GSEs.", should read, "... in regard to the financial practices of these GSEs.".

J. D. MacDonald -
9/7/2008

In quest of proper English, from a University publication(?):
"...with regards to the financial practices of these GSEs." with regards to the financial practices of these GSEs.

Amir Syed -
3/1/2008

Amir Syed -
3/1/2008

Greg P Hartz -
6/2/2004

Question: When Freddie Mac was chartered by Congress in 1970, was it government funds that capitalized it?

Barbara Cornett -
12/10/2003

Corporations have the science of ripping off the taxpayer down to an art. Private individuals are making money hand over fist without regard to banking principles and laws which would guarantee that people will not lose their money. They should be called Neil Bush instead of Fannie Mae and Freddy Mac.

Republicans whine about socialist democrats but support the banks in their ripoff of the taxpayers.

I once asked my Congressman if he would do something about bankcard companies that charge usurious 20% interest rates and he told me that they made so much money he couldn't do anything about them if he wanted to. They drove the mob out of business. where is it all going to end?